With the market betting that the Federal Reserve will aggressively cut interest rates next year, "loose trading" has heated up, causing stock and bond markets to soar, the US dollar to fall, and gold prices to soar.
But now this momentum has shown signs of fatigue, with the stock and bond markets slowing down, the US dollar consolidating, and gold prices falling from their high levels. The performance of the "global asset pricing anchor" is particularly prominent, with the 10-year US Treasury yield falling nearly 100 basis points from its high of 5.02% on October 19th. On December 7th, the 10-year US Treasury yield remained near a three-month low, rising 1 basis point to 4.128% in late trading, while the two-year US Treasury yield fell 3 basis points to 4.578%. With investors anticipating that the Federal Reserve will not raise interest rates again and is expected to lower rates in the first half of next year, the three major US stock indexes have been on the rise for five consecutive weeks in the past five weeks, but cautious sentiment has emerged in the stock market in recent days.
Regarding this, Wang Xinjie, Chief Investment Strategist at Standard Chartered China's Wealth Management Department, analyzed to 21st Century Business Herald reporters that the recent return in risk appetite is due to the market's widespread expectation that major central banks around the world have completed this round of interest rate hikes. As inflation data cools down, the market predicts that the Federal Reserve will initiate interest rate cuts earlier in 2024, with a larger magnitude, and based on this, price risky assets. As of December 7, the expectation of the Federal Reserve to cut interest rates in March next year has risen to more than 60%, which has also caused a sharp drop in the yield of the US 10-year treasury bond bonds, a rise in stocks, bonds and gold, and a fall in the US dollar.
The future still faces numerous uncertainties. Wang Youxin, a senior researcher at the Bank of China Research Institute, told 21st Century Business Herald reporters that currently, the market has a consistent expectation that the Federal Reserve will stop raising interest rates next year and enter a cycle of interest rate cuts. However, there are still differences on when and how much interest rate cuts will be made. The impact of the liquidity environment on the financial market next year may be weaker than this year, But the downward pressure on the US economy next year will be greater than this year. Overall, the financial market will continue to be highly volatile.
The Misty Path of Interest Rate Reduction Disturbs the Market
As investors waver between anticipating an earlier rate cut from the Federal Reserve and worrying about excessive bets on aggressive rate cuts, the market is also volatile.
According to data from the US Department of Commerce, due to the decline in energy prices, the PCE price index in the US increased by 3% year-on-year in October, the smallest increase since March 2021, and remained unchanged month on month. After excluding food and energy, the year-on-year growth rate of the core PCE price index in October fell from 3.7% in September to 3.5%, and the month on month growth rate slowed down from 0.3% in September to 0.2%.
Given the significant progress made by the Federal Reserve in its fight against inflation, the market is betting that the Federal Reserve may cut interest rates by a total of 125 basis points next year, far exceeding the forecast of a 50 basis point rate cut by the Federal Reserve in September. "Loose trading" once plunged the market into a frenzy.
But after the recent sharp rise in the stock and bond markets, the expectation of the Federal Reserve cutting interest rates next year has been initially digested, and the momentum of "loose trading" has slowed down.
Wang Xinjie told reporters that the expected interest rate cut will support the rise of risky assets, but such a significant change in expectations in the short term exceeds historical performance. From the perspective of historical interest rate reduction cycles, the Federal Reserve will initiate a rate reduction cycle when the economy declines to a certain extent or encounters major risk events. At present, the decline in US economic growth and the cooling of inflation at the beginning of next year may not be as rapid as market expectations, and considering the lessons of the 1970s, it is highly likely that the Federal Reserve will not cut interest rates early to support the economy. Therefore, the marginal changes in expected interest rate cuts will affect the trend of risk assets, especially if some major macroeconomic data exceeds expectations.
According to Li Wei, Chief Investment Strategist at BlackRock Global, the global market is expected to experience greater volatility in 2024 as the number of rate cuts by the Federal Reserve may be less than many investors had anticipated. "The market's expectations for interest rate cuts are a bit excessive. To achieve such a path, the economy must face serious problems. The Federal Reserve may cut interest rates in the second half of next year, but compared to previous economic cycles and recessions, the frequency of rate cuts is much lower."
Can loose trading continue?
As the anchor of global asset pricing, the 10-year US Treasury yield has fallen nearly 100 basis points from a high point, and the future trend has become the focus of market attention.
The market trend driven by optimistic sentiment in the short term may come to an end, and the market's bet on interest rate cuts has been largely digested. Gennadiy Goldberg, an analyst at TD Securities, said that the rise in the US treasury bond bond market has approached a worrying level, especially at the long end of the interest rate curve. At present, there may have been some overbought situations in the US bond market.
Andrew Hollenhorst, chief American economist of Citigroup, analyzed that everyone agrees that the Federal Reserve will cut interest rates from 2024, but the market is underestimating that stubborn inflation will delay the time point of interest rate reduction. In the coming months, core inflation may strengthen, and the market's narrative of a decline in inflation will be shattered. Even if inflation continues to remain moderate, as long as economic activity remains relatively stable, the Federal Reserve may take this opportunity to enhance its credibility and wait for stronger evidence that inflation has continued to slow down.
However, in the medium to long term, there is still room for a decline in US bond yields. Wang Youxin analyzed to reporters that from the factors that affect yield, conventional factors include policy interest rate trends, monetary policy expectations, judgments on inflation, and economic growth expectations, as well as the default risk of the bond market itself. At present, the recent decline in US Treasury yields is mainly caused by various factors such as the expectation of the Federal Reserve's possible adjustment of monetary policy, increased downward pressure on the US economy, and temporary easing of the US fiscal year budget game. Considering that the downward pressure on the US economy will further increase next year, the Federal Reserve may gradually enter a rate cutting cycle, and inflationary pressure will further ease. Therefore, There is still room and possibility for a downward trend in the yield of 10-year US Treasury bonds in the future.
Can "loose trading" continue in the future? Wang Youxin believes that there is a certain degree of competition in the current market for "loose trading", and the judgment on the degree of interest rate cuts is more optimistic than that of the Federal Reserve. As the market's optimistic sentiment gradually dissipates, the emotional factors that stimulate the rebound of the financial market are gradually stabilizing. However, it cannot be denied that if more unfavorable economic data is released in the future, it will provide more evidence for the economic downturn, support the Federal Reserve to suspend interest rate hikes or enter a cycle of rate cuts, and financial market performance will still receive some boost before and after the data release and policy shift.
How to interpret general assets?
There is a high probability that the Federal Reserve will start a rate cutting cycle next year, but there is still uncertainty about when and how much it will be cut under the data dependence model. How will the market interpret this in the future?
In terms of the stock market, Wang Xinjie expects that the stock market in 2023 not only reflects the process of global investors shifting from recession pricing to economic soft landing pricing, but also reflects changes in monetary policy expectations. In 2024, it is expected to be influenced by the game between economic growth and interest rate cuts. In the first half of the year, there may be a boost in the resilience of the US economy and expectations of interest rate cuts. However, if the expectations of interest rate cuts cool down, it may drag down the stock market.
In terms of performance, the profits of global listed companies in 2023 are expected to remain unchanged from last year, and the market generally expects a return to profit growth in 2024. Asian (excluding Japan) listed companies are expected to lead in growth. Wang Xinjie also stated that the high-quality growth stocks in the US stock market and the structural improvement in the Japanese stock market are also worth paying attention to.
Overall, most institutions such as Bank of America, Deutsche Bank, and Royal Bank of Canada are currently optimistic about the US stock market next year. It is expected that the S&P 500 index will rise above 5000 points by the end of next year, but there are still some pessimistic voices in the market. Jason Hunter, head of technology strategy at JPMorgan Chase, stated that he believed the market had mistakenly digested the expectation of a "soft landing" for the US economy, and was overly optimistic about the Federal Reserve's ability to suppress inflation while avoiding an economic recession. The actual outlook for the US economy will be even dimmer than market expectations, and the US stock market will also experience selling as a result, possibly falling to 3500 points by mid next year.
In terms of bonds, Wang Xinjie believes that in the scenario of an economic "soft landing", investment grade government bonds in developed markets are a better investment choice. Starting from the current level of return. Investing in bonds can bring good returns, and a higher level of yield indicates that bond investment returns are expected to be higher in the coming years. It is expected that the bond market will still fluctuate in the first half of next year due to the impact of the economy and expectations of interest rate cuts. However, after the path of interest rate cuts is determined, the yield of interest rate bonds may further decline.
The US dollar may come under pressure in the future. Wang Xinjie expects that the probability and space for further decline in yield in the short term are small, and there is still room for a slight rebound in the US dollar. However, in the medium to long term, the US dollar may still face pressure as the Federal Reserve ends its monetary tightening cycle and interest rate spreads continue to narrow. After the interest rate cut path is determined, the US dollar may further decline, reflecting expectations of reduced interest rate spreads between the United States and other major countries.
The recent surge in gold may still have upward potential. Peter Schiff, Chief Global Strategist at Euro Pacific Capital, said that although gold prices have retreated significantly after hitting historic highs, the true bull market for precious metals has only just begun. "Even in the face of the Federal Reserve's aggressive interest rate hikes and its tough talk of fighting inflation at all costs, the dollar has strengthened and the yield of US treasury bond bonds has risen. Gold has been quite strong before. When the Federal Reserve raises interest rates, gold can once rise above $2000/ounce, so when the Federal Reserve stops raising interest rates and is about to cut interest rates, gold's performance can be expected."
However, there are also views that are relatively cautious. Wang Xinjie stated that gold has been affected by geopolitical conflicts and the decline in 10-year US Treasury yields, and has risen to historical highs since early October, reflecting the impact of future interest rate cuts. Although there is still room for a decline in bond yields, the magnitude of the decline may be limited by the still expanding economy. In this context, he holds a neutral view on gold. In addition, under the background that the global economy may continue to slow down and the completion of China's fixed assets investment is bottoming out, the overall performance of commodities may be under pressure.